Interview with Declan Fallon

May 24th, 2006

For the tenth interview in the StockTickr Interview Series (RSS feed), I spoke with Declan Fallon. Declan maintains a popular site about stock trading and has his own stock pick newsletter service.

Although a lot of traders come from varying professions, Declan might win the award for the oddest. Read on to see what Declan’s day job is and to understand Declan’s two main styles of trading. Judging from his results, he’s done quite well.

StockTickr: Tell us a little about yourself, Declan.

Declan: I am perhaps a little different to the mainstream with respect to my background. I hold a degree in Zoology and a Ph.D. in Nematology, both obtained in Ireland. I currently work in Hawaii (9-to-5 job) as a researcher developing sustainable systems for the suppression of plant-parasitic nematodes; or in english, I try to kill troublesome worms. For recreation purposes I am a mentally challenged (read “choker”) Golfer. Married to my lovely wife, who has so far been very tolerant of the late nights I spend working on my website.

StockTickr: How did you get started trading stocks?

Declan: High School Stock competition. Traded this never to be heard of again Irish company called “Kish Resources” buying at 2 pence selling at 4 pence on my way to victory. This was before I knew about slippage, commissions and junk stocks; I learned the hard way later on.

StockTickr: Most traders have a horror story about losing their shirt when they first started trading. What’s yours?

Declan: Three years ago and it was to do with options. Stocks: LEXR, IMAX, VISG. These were not short term options, this was buying as long a time frame as I could, in the money options. I thought I was relatively protected with the time decay – sadly I wasn’t. The stocks barely budged as time ticked away. Had I stuck with just buying the stocks I would have come out okay. I stick with buying the underlying stocks now and sometimes sell covered calls when these stocks are overbought on stochastic measures; it has been a far more successful strategy for me.

StockTickr: Do you trade for a living now?

Declan: No. You need money to make money and I would be undercapitalized to go into trading full time. But as an aside to that, learning to deal with the emotion of trading is something which money can’t buy; trading for a living would probably be a roller coaster ride for me.

For now, running my website and blog consumes most of my free time, so my real-life trading generally involves holding stocks for a period of weeks to months. I remain a researcher (of stocks and science) first and foremost.

StockTickr: What single lesson did you learn along the way that has helped you the most in your trading?

Declan: The market always offers fresh possibilities; if in doubt, get out (I am still learning this!).

StockTickr: Describe your style of trading. How long do you typically hold stocks?

I operate two styles of stock entry:

[i] Price breakouts on volume (nth day high and % rise above nth day mean volume)
[ii] Value buying (oversold stochastics and/or moving average)

I use what I call “Secondary Indicators”; chiefly the NASDAQ Composite Bullish Percent Index, NASDAQ Stocks Above 50 Day Moving Average and NASDAQ Summation Index as a gauge of overall market health given they oscillate quite nicely. If these indicators are oversold, markets are low risk to buy. If these indicators are overbought, markets are high risk to buy.

In February of this year all three indicators were overbought and I switched to a position of “Cash is King”; this opinion hasn’t changed.

To exit a position I look at the following;

[i] For stocks under $10 I look to whole number resistance; in particular $1, $5, $10 as key primary supply/demand areas.
[ii] In my ROTH I use options to sell covered calls on existing positions. I let the trade exit itself if it rallies past the strike price. If the stock takes a dive while the covered call is in play, I look to buy back the call and then assess whether to sell the stock or sell fresh calls on the next overbought market condition. Factors such as nearby support would be important in this regard.
[iii] In momentum plays (Breakout stocks), I look to raise stops to reaction lows of at least 2-3 weeks in length. If the stock goes parabolic I may sell when I see exhaustion gaps/bearish candlesticks, and/or a test of a channel line drawn on a semi-log chart.

As for a holding time: weeks, months and in some cases, years.

StockTickr: What’s your exit strategy for winning and losing trades?

Declan: For winning trades I look at price projections based on pattern size and/or point-n-figure targets. Fresh patterns often mean fresh price targets, so this in factored in too. Winning trades either reach their target price, or hit a raised stop.

For losing trades it is a break of nearby support (or prior reaction low). I use stops because the further west of New York you live, the progressively harder it becomes not too. I usually only get to see a couple hours of the trading day because I don’t rise at 3:00 am Hawaii time to watch the markets.

StockTickr: What 3 books do you recommend traders read?

Declan:

StockTickr: What is your typical R value per trade? i.e. what % of your portfolio do you risk with each trade?

My basic risk per trade depends on the stock selection method I use.

If I think markets are oversold I will draw stocks from my breakout scan. Because I am waiting for the breakout to happen before I enter, the risk becomes higher. So, these stocks carry an average risk of 10% per trade. The wider risk gives the trade a little more room in markets which are volatile and ‘fearful’.

If I think markets are overbought I will look to buy stocks in pullbacks and/or trading close to key moving averages (20-day/50-day/200-day MAs), support, or oversold stochastics. Because markets are overbought I look to reduce the risk on individual trades to protect against sudden reversals. Stocks in pullback average a risk of 6% per trade.

The degree of risk will vary; eg. lower priced stocks will likely carry a higher risk because support is a bigger % away than may be the case with a stock priced at $50 or above. For the stocks I feature on my website I will suggest what price to aim for and where I think a stop should go. It is easy enough to figure out the % risk based on the current price and my suggested stop price. If this is amenable only then one can consider what the upside potential might be.

As for % allocation of risk according to portfolio size – I am a ‘cheater here’. Optimally, risk should be no more than 2% of the total available, but since I work with a smaller cash pool mine runs closer to 5%. I also have to be careful where commission costs are a greater factor than would be the case had I a larger capital pool to work with – so day trading is out for me (not to mention the time difference). Commission costs are the silent killer on my account.

StockTickr: What technical indicators could you not live without?

Declan: Until recently I have only ever used three indicators: a trend measure (MACD), a volume measure (on-balance-volume), and a momentum measure (slow stochastics). I recently added the ADX as an additional trend watcher. But, one has to be careful using to many indicators which give you the same information.

StockTickr: How do you think the market has changed over the last several years?

Declan: Fear is back. For most participants the market was a free ride from the 80s to 2000. Occasional crashes were just that – a quick collapse before the upward trend resumed. But now there is a sense of looking over ones shoulder, particularly in the Tech markets. You can look to the Nikkei in the 90s from a technical perspective and ask yourself is the worst over for US markets? It looks like it has taken the Nikkei 13 years to bottom (assuming 7,603 is its absolute bottom). It will likely take longer than 13 years (given markets take longer to climb than to fall) before 1990 highs are challenged and this assumes there is no retest of 7,603 as a double/triple bottom, which would add even more time to the recovery. Translate something similar to the Tech markets here and one could be looking at 2030 before we see the NASDAQ at 5,000 and a perhaps a sub-1,000 low between now and then. This fear has the markets trading in a scrappy fashion since the start of 2004 and this fear helped fuel the recent commodity rally. However, fear could turn out to be a good thing, allowing markets to inch higher.

Bulls could argue for strength in the NYSE Composite, S&P, and Dow indices – but future innovation and progess won’t come from companies in these indices, this is why participation by the NASDAQ is important.

StockTickr: How have you adapted?

Declan: Stick to trending stocks. The sideways market we have seen over the last couple of years has been difficult in this regard. A strong bear market will have buying opportunities just as good as those from a bull market. Trending markets have trending stocks, just the sectors of strength change depending on a bullish or bearish bias.

StockTickr: Do you backtest and why or why not?

Declan: No. Why?

[i] A system which backtests well is not necessarily one which will perform in the future
[ii] (Perhaps the most important) The data set available for backtesting is limited by time. Historical data avaliable for manipulation by a computer is heavily biased by bullish market conditions (1980-2000). A system which successfuly tests in this environment is unlikely to test well outside of those conditions. There is a limited amout of bear market data available; 2000-2003 is the longest continous period from which one can use in this regard. And as for sideways market conditions there is only 2004-2006 to use. If you were to develop a system based on the above data you would want to use 2 years of bullish action, 2 years of bearish action, and 2 years of sideways action – minimum. The problem with this is that outside of the above periods, there is no similar period of available data on which you can then test your system.
[iii] Intiial stock selection is best based on simple measures: moving averages, volume, nth day highs. There is no need to hone a system to minor degrees. Once you have a list of 30-100 stocks you can eyeball for good candidates based on aforementioned technical parameters (MACD, OBV, Stochastics).

StockTickr: What is the most common, but easily corrected fault you see in traders?

Declan: Overtrading. Its hard to stay out of the market. If you have to trade and the market looks iffy, trade small.

StockTickr: What advice can you offer traders who are just starting out?

Declan: You need to have a plan and you need to have real money on the line. It doesn’t have to be alot of money (I started with less than $5,000, but more is better). Experiencing the highs and lows and learning how to react to these highs and lows will dictate if trading is for you.

StockTickr: What do you like best about trading?

Declan: The freedom. I would like it as a career in some shape or form (a full-time analyst would be ideal, but I can’t afford to give up the day job yet!). I also like crunching numbers; since starting my website in 2004 I am fast approaching the 2,500 mark of sample trades. I do like to number crunch.

StockTickr: Thanks, Declan!

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Previous interviews in the StockTickr Interview Series (RSS feed):

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